What is the IR35 business entity test for contractors?

Are you inside IR35?

Are you inside IR35?

The potential tax benefits of contracting through a limited company see many contractors choose this option as opposed to setting up an umbrella company.

While setting up and running a limited company involves a significant amount of administration and paperwork, the tax savings coupled with the limited liability of such a set up appeals to many of those keen to work for themselves.

However, unlike contractors working under an umbrella company, limited company contractors have another important issue to consider - IR35 compliance.

The most pressing concern as far as IR35 is concerned is whether you fall inside or outside the legislation and determining this is not as easy as it may appear.

Although IR35 in itself has not changed, HMRC has improved its guidance on the issue and developed more specialist and better trained teams.

HMRC has also introduced a new IR35 business entity test to help contractors determine their level of IR35 risk and their chances of being subject of an investigation.

The test includes 12 questions which contractors can answer about their business practices. The answers are weighted and HMRC will use the results to screen limited company contractors and place them in risk categories.

While details remain unclear at this point, it is thought that those who fall into medium and high-risk bands are more likely to be the subject of full-blown investigations from the authorities, certainly more than those in the low-risk bands.

The questions that make up the test are:

1. Does your business own/rent separate business premises which are separate from your home and client's premises?

Answering yes gives you ten points.

2. Do you need professional indemnity insurance?

Answering yes gives you two points.

3. Has your business had the opportunity in the last 24 months to increase your business income by working more efficiently e.g. by finishing the work/project earlier than projected but still receiving the full agreed payment?

Answering yes gives you ten points.

4. Does your business engage one or more workers who generate at least 25 per cent of your business turnover annually?

Answering yes gives you 35 points.

5. Have you been engaged on PAYE employment terms by your current client/end user within the last financial year with no significant changes to your working arrangements?

Answering yes gives you minus15 points

6. Has your business invested over £1,200 on advertising, excluding entertainment in the last 12 months?

Answering yes gives you two points

7. Does your business have a business plan with cash flow forecast, that is regularly updated, and a business bank account which is separate from your personal account and identified as a business bank account by the bank?

Answering yes gives you one point.

8. Would your business have to bear the cost of having to rectify any mistakes?

Answering yes gives you four points.

9. Has your business been unable to recover payment for work done during the last 24 months in excess of ten per cent of annual turnover?

Answering yes gives you ten points.

10. Do you invoice for work carried out prior to being paid and negotiate payment terms?

Answering yes gives you two points.

11. Does your business have the right to send a substitute?

Answering yes gives you two points.

12. Has your business hired anyone in the last 24 months to do the contracted work you have taken on?

Answering yes gives you 20 points.

If, at the end of the test, you have scored between zero and ten points, you are likely to be deemed high risk, while 11 to 20 points will put you in the medium-risk band and more than 21 points will see you classed as low-risk.

This test is designed to help you determine your risk of IR35 non-compliance. If you are worried about your score, speaking to an accountancy services provider, such as PayStream, can be a good way forward, as they will be able to discuss your situation and advise accordingly.